Download Opportunity Cost

SCARCITY &
OPPORTUNITY COST
WHAT IS SCARCITY?
Scarcity is the fundamental economic
problem of having seemingly unlimited
human wants in a world of limited
resources
DEFINE THE TERM OPPORTUNITY COST
 “When asked how much something costs, people
usually answer by giving its price, or money
cost. Economists usually measure cost differently,
using what they call opportunity cost, defined as the
value of the next best alternative opportunity that is
given up in order to do something.”
IN SIMPLER TERMS:
The cost of passing up the next best choice
when making a decision.
EXAMPLES:
 Resources are scarce. Our desires are not. This
means that we must make choices. When we choose
to watch T V rather than do our homework, we lose
the benefits that doing our homework would have
brought.
EXAMPLES:
If you have $10, there are many things you
could do with that money. All of the options
(or alternatives) that you don’t choose are
forfeited. But it is the cost of the next best
alternative (your second choice) that is used
when calculating opportunity costs.
THE NEED TO IDENTIFY OPPORTUNITY COST
 To choose something is to not choose something
else.
 Making a good decision takes into consideration
what is lost when the decision is made.
 Every time a decision is made, because we have
limited resources, there is a foregone alternative.
 Opportunity cost is actually the value of the next highest-valued alternative use of that resource.
DISCUSS FACTORS THAT INFLUENCE THE INCLUSION OF
OPPORTUNITY COSTS IN BUSINESS DECISION -MAKING.
Experience—do you know all of the
alternatives that exist? For example, a 2nd
grader learning to play football may not
realize that an opportunity cost of kicking a
field goal for three points is the chance of
making a touchdown for six (or seven) points.
DISCUSS FACTORS THAT INFLUENCE THE INCLUSION OF
OPPORTUNITY COSTS IN BUSINESS DECISION -MAKING.
Vagueness of information—is it possible to
calculate the value of the next best
alternative?
DISCUSS FACTORS THAT INFLUENCE THE INCLUSION OF
OPPORTUNITY COSTS IN BUSINESS DECISION -MAKING.
 Thoughtfulness—Has the situation been explored thoroughly
enough to see the decision in light of other alternatives? An
example of looking at the same question in 3 different ways:
"If we build a dam, we'll have better flood control
and cheaper electricity. If we don't, then we'll
experience occasional flooding, and electricity
will be more expensive."
"If we build the dam, it will provide us with flood
control and cheaper electricity, but it will cost us
$100 million."
 "If we build the dam, we'll have flood control and cheaper electricity. But
the $100 million to build the dam could be used instead to build two new
high schools."
DESCRIBE PROBLEMS WITH BEING ABLE TO IDENTIFY
OPPORTUNITY COSTS.
It is difficult to place a value on some
opportunity costs, such as time, experience
gained, etc.
For example, part of the opportunity cost of
deciding not to go to college is foregoing
knowledge about the world, developing
lifelong friendships, exploring career options,
and learning about one’s self.
EXPLAIN THE RELATIONSHIPS BETWEEN OPPORTUNITY
COSTS AND TRADE-OFFS.
 Trade-of f: an exchange for one thing in return for another
 Opportunity cost: the value of the next-highest-valued
alternative
 Example of trade-off: watching T V instead of doing your
homework
 Example of opportunity cost: received enjoyment from
watching T V, but sacrificed the points you would have received
from your homework, the knowledge doing your homework
would have created, the feeling of accomplishment that
having completed your assignment would have created.
WHY/WHEN ARE OPPORTUNITY COSTS INCLUDED IN A
BUSINESS DECISION?
 “Because of its usefulness as an analytic tool. In a
market economy, people seek to make a profit. To do
that, they must utilize their resources as efficiently
as they can, in order to bring back the greatest
benefit to themselves. Many, many factors must be
weighed. In making all those decisions, it is a great
help to know the value of the next-best thing that
one could have chosen.”
IDENTIFY THE OPPORTUNITY COSTS ASSOCIATED WITH
SITUATIONS INVOLVING ECONOMIC DECISION -MAKING.
 When considering a choice, ask yourself three
questions:
 What alternative opportunities are there?
 Which is the best of these alternative opportunities?
 What would I gain if I selected my best alternative
opportunity instead of the choice I'm considering?”
(this is the opportunity cost)